Comparative and Competitive Advantages

Since M. Porter (1990) published “The Competitive Advantage of Nations”, competitive advantage worldwide began to spread and had a significant impact on the theoretical researchers and policy makers around the world. Nevertheless, there are still some shortcomings in people’s understanding of competitive advantage. A major misunderstanding of them is that the followers of competitive advantage always tend to consider the theory of competitive advantage and comparative advantage as two opposing concepts, or think the purpose of proposition of competitive advantage is just to replace the theory of comparative advantage. [1] This paper argues that such opposing views that separate these two advantages are mostly wrong.

The misconception between comparative advantage and competitive advantage will bring potential harm to the national (or regional) economic development pathways. The idea may lead countries (or regions) to choose strategy against their own comparative advantage in the formulation of economic development strategies. As a result, a decision which should focus on improving the industrial competitiveness conversely harms the national economic competitiveness and development prospects

My analysis will show that in the comparative advantage and competitive advantage, there doesn’t exist a relationship of mutual opposing substitution or contradiction. In contrast, only give full play to the comparative advantages of the economy, can one nation (or region) be possible to create and sustain their own industrial competitiveness. I will also apply this conclusion to the situation of developing countries which never attracted the scholar’s attention before in this region.

Accordance with the above study, the framework of theoretical study accordingly divided into the following parts: The first and the second part will first review the competitive and comparative advantages respectively; On this basis, the third part will give a detailed analysis of the relationship between these two advantages; The fourth part is an empiric study. It applies the theoretical model to the developing country and describes the significant meaning of the relationship between the two theories to the economic development and their selection of ways to develop. Finally, discussions and conclusions will be given at the end of this essay.

THE MAIN VIEWS OF COMPETITIVE ADVANTAGE

Porter (1985) emphasized competitiveness at the level of a firm in terms of competitive strategies such as low cost and/or product differentiation. Hoffman (2000) developed a definition of sustainable competitive advantage (SCA) based on Barney (1991) together with dictionary meanings of each term as “An SCA is a prolonged benefit of implementing some unique value-creating strategy not simultaneously implemented by any current or potential competitors along with the inability to duplicate the benefits of this strategy.” A number of writers on competitive advantage have focused on the determinants of competitive advantage such as important attributes of the firm: rareness, value, inability to be imitated, and inability to be substituted (Barney, 1991); important potential resources classified as financial, physical, legal, organizational, informational, and rational (Hunt & Morgan, 1995); ability in developing superior core competencies in combining their skills and resources (Prahalad & Hamel, 1990); a set of dynamic capabilities-capabilities of possessing, allocating and upgrading distinctive resources (Luo, 2000). A number of studies have also analyzed the role of individual factors such as intellectual property rights, trade secrets, data bases, the culture of organization, etc. (Hall, 1993), ethics capability (Buller & McEvoy, 1999), corporate reputation (Ljubojevic, 2003), diversity in workplace (Lattimer, 2003) and corporate philanthropy (Porter & Kramer, 2002). The central focus of these contributions is still on firm-specific factors of competitive advantage. [2] 

Since Porter’s theory is considered as the masterpiece to describe this theory, my discussion naturally focus on the core of Porter’s points of view. Before the “Competitive Advantage of Nations” was published, Porter’s studies mainly focused on enterprise strategy and firm’s competitiveness. Porter extended his theory in the field of firm competitiveness to industrial and national level, and then formed his theory of national competitive advantage.

The sources of obtaining low-cost competitive advantage usually come from the following aspects: special resource advantages (lower labor and raw material costs); other productive technology and productive methods that can be obtained under lower cost; the development of economies of scale. The product differentiation based competitive advantage on the continuous investment and innovation of the aspects such as equipment, technology, management and marketing, and thus created better product to meet the needs of different customers. Product differentiation-based competitive advantage is known as a high-level or advanced competitive advantage mainly because: (1) Compared with low-cost competitive advantage, the successful differentiation competitive advantage can often bring higher earnings for the enterprise and therefore represents much higher productivity levels; (2) compared with low-cost competitive advantage, the differentiation competitive advantage is more difficult to imitate by competitors and thus more likely to be maintained in the long term.

In order to create differentiation competitive advantage, the best option is ongoing investment and innovation. Therefore, a favorable business environment is a crucial condition of continuous investment and innovation for enterprises to create advanced competitive advantage. In the theory of national competitive advantage, “diamond system” (1990) supplies a concrete description of environment of investment and innovation. Specifically, the “diamond system” includes the four main factors: (1) factors of production, including the primary factors of production (the general human resources and natural resources) and the created factors of production (including knowledge, capital and infrastructure); (2) demand conditions, including the structure of domestic demand, market size and growth rate, the quality of demand, the degree of internationalization of demand; (3) the performance of related industries and supporting industries, including the vertical support (support from upstream business in the equipment, parts and components) and the horizontal support (production cooperation and information sharing between similar enterprises); (4) firm strategy, structure and competition, including operational philosophy, goals, employee motivation, the status of the competitors in the industry and so on.

According to Porter’s analysis, it is not necessary to match all the factors of diamond system when forming the low-level competitive advantage. Usually, Obtaining low-cost competitive advantage only needs enough primary factors of production. Relying on building a vast domestic market to achieve economies of scale in production is another common source of low-cost. However, differentiation competitive advantage needs to be established on a mutual coordination of all the factors in the diamond system. For example, high levels of human capital, specialized research institutions, good infrastructure provide the necessary conditions of production factors for company’s research and development activities; professional and demanding customers of domestic market and fierce competition within industry, provide sufficient pressure and stimulation for the firm’s investment and innovation; Finally, the suppliers possessing a same competitive advantage ensure the firm’s requirement of quality for its equipments and raw materials.

Through his diamond system, Porter explained how an industry of a country can achieve lasting international competitiveness. After that, Porter developed this firm competitiveness theory into an economic development theory. According to Porter’s logic, the objective of one country’s economic development is to achieve a higher national income, while income is determined by the level of productivity of the enterprises or industries in the country. Since only the development of high-level (differentiation) competitive advantage can enable enterprises to achieve high levels of productivity, the status of national income will also depend on the availability of obtaining high-level competitive advantage. Thus, Porter connected the competitive advantage theory with the country’s economic development, and eventually developed his competitive advantage theory into the theory of national competitive advantage.

COMPARATIVE ADVANTAGE AND TRADE THEORY

Unlike the starting point of competitive advantage, the appearance of comparative advantage mainly drew from the people’s attention on trade patterns. Therefore, any further development, introduction or evaluation of theory of comparative advantage can’t be separated from the whole process of evolution of the framework and background of trade theory.

Generally speaking, people consider David Ricardo’s (1817) study on international trade as a beginning point for the theory of comparative advantage. According to Ricardo’s discussion, comparative advantage is the opportunity cost differences among different countries when producing the same product which caused by the different labor productivities in different countries.

From the perspective of modern economics, Ricardo’s theory of comparative advantage has many limitations. The most unsatisfactory aspects of these limitations mainly include: (1) only one factor of production–labor; (2) under multi-factors circumstances, the theory meets difficulties in interpretation of the source of comparative advantage. These discontent aspects led to the further developments of trade theory in which the most successful is the Heckscher-Ohlin’s “2x2x2 model” (1933). The theory constructed a “two countries, two commodities, two factors of production” model, finding reasons for international trades from the angle of differences in factor endowment structure and the differences of relative factor prices in the international area. In general, the theory of comparative advantage we talked about today is basically based on Heckscher-Ohlin’s theory.

The proposal of “Leontief problems” putted the general applicability of Heckscher-Ohlin theory into question. Some researchers believe that they can solve the problem through adding some factors into the Heckscher-Ohlin theory. Another part of the researchers (Krugman, Helpman, Lancaster, etc. from 1980s) are not satisfied with the simple improvements of Heckscher-Ohlin theory. They tried to give up some important assumptions to construct “new trade theory”: (1) give up the assumption of constant returns to scale; (2) give up the assumption of same possibility in obtaining productive techniques, that is called “Differences in the availability of technologies” which can be used to explain the theory of trade between developed countries as well as trade between developed and developing countries.

Finally, the empirical tests (Deardrof, A. (1984), Perdiks & W.A Ker (1998)) have proved and supported most of the theories including the Heckscher-Ohlin model of comparative advantage theory and new trade theory. Meanwhile, the results showed that there isn’t one factor has an overwhelming explanatory power which means that the phenomenon of international trade is based on multi explanatory variables.

THE RELATIONSHIP BETWEEN THESE TWO THEORIES

Now I turn to the core part of my article, namely, the relationship between the two theories discussed above. I will bring forth two respects to illustrate this problem.

First, I will discuss the relation between competitive advantage as a trade theory and comparative advantage. From the above parts of the article, we see that competitive advantage can be used to explain the origins of international competitiveness of one enterprise or industry. Therefore, competitive advantage itself directly constitutes a theory of international trade theory. In this way, we can put the comparison of these two theories in the overall framework of international trade theory.

According to Porter, although competitive advantage theory discussed the “low cost competitive advantage,” this theory specially emphasized on how an enterprise or state form its own “product differentiation competitive advantage.” Furthermore, the competitive advantage theory believes that product differentiation comes mainly from continuous innovation of firms. From this perspective, as a trade theory, competitive advantage is mainly used to explain the international and inner industry trade with similar structure of factor endowment. Therefore, it is contained in the category of “new trade theory”.

The second part tells us that there isn’t a confrontational or substitute relationship between the theory of comparative advantage and the new trade theory. In fact, the relationship between the two is closer to a mutually complementary relationship. Due to the multi-causality of international trade, we can hardly expect to explain all phenomena of the trade through only one theory. Thus, we often are inclined to use the comparative advantage theory to explain trade between the countries with very different structures of factor endowments, while use “new trade theory” to explain the trade between countries and industries with small differences in factor endowment. On the other hand, the second part pointed out that a variety of empirical tests of different trade theory proved every trade theory has its reason to exist. Therefore, we can not abandon or reject the theory of comparative advantage just because it is difficult to explain the trade phenomenon between countries and intra-industry with similar endowment structure. This is why the theory of comparative advantage is firmly still the dominant case in the popular textbook of trade theory when many “new” trade theories have been developed today.

Second, I follow the “diamond system” to analyse the relationship of comparative advantage and competitive advantage. We believe that making good use of the comparative advantages in one economy is a necessary condition for the existence and performance of the four major factors of “diamond system”. In another word, exploiting the comparative advantage is the foundation stone for a country to create and maintain its industrial competitive advantage. The reasons include the following aspects:

First is the factor of production. Both comparative advantage and competitive advantage have emphasized the importance of factors of production in creating competitiveness for firms and industries. Theory of comparative advantage underlined that a firm should take advantage of their relatively abundant factor of production in order to reduce cost and strengthen competitiveness. Unlike comparative advantage, competitive advantage cares more about the so-called high-level factors of production (e.g. human resource, universities and institutions, etc.). Potter (2002) rightly points out that “Advanced factor of production is one kind of factor of production that was created by consecutive investment from government, businesses and individuals”. However, the creation of advanced factors of production necessarily requires substantial investment which is guaranteed by the country’s economic surplus of past productive activities. Lin Yifu, Cai Fang & Li Zhou (1999) and Lin Yifu (2002) pointed out that only follow comparative advantage to organize productive activities, can enterprise and economy maximize its economic surplus. Conversely, if the enterprise or economy operates against its comparative advantage, it may bring loss or even failure, not to mention generating profit and contribution to accumulation of advanced factors of production. Therefore, following the comparative advantage to make full use of existing factor endowments and choose the corresponding industry, technology, productive activities is the premise for obtaining competitive advantage for one industry and state.

Second is about competition within the industry and demand condition. Porter (1990) said that the fierce competition within the industry is able to provide sufficient pressure to increase investment in advanced production factors and R&D activities, thus contributing to promoting innovation activities. However, for a particular industry, only it is in line with the economy’s comparative advantage, can the industry have a healthy competition in the market. Once the government decided to promote some of its industries which may against the comparative advantage of entire economy so as to “catch up” with other country, healthy competition in the market will be damaged. This is because: (1) catch-up companies can’t access to technology advantage in the short term (not differentiation); (2) These companies can not use the economy’s comparative advantage to form cost advantages (not low-cost). Under these two conditions, this industry’s enterprises do not have the self-survival ability unless the government implements measures to protect them (Lin, 2002). The history of economic development in developing countries has shown that the only result of reckless “catch up” is to lead the industry to monopoly. Under the conditions of monopoly, companies are keen to protect the monopoly by rent-seeking activities, rather than a positive innovation. The similar situation comes to demand conditions. In the monopolistic industry, the government’s policy will always more or less be in favor of protection of manufacturers rather than customers, which also lifts the cost of “critical” demand from customers. Therefore, only a country develops its economy in accordance with comparative advantage, can the industries have the largest extent of competition.

Third is about related and supporting industries. Theory of competitive advantage stressed the importance of related and supporting industries (or industrial clusters) for enterprise and industry to create competitive advantage. However, a good promising industrial cluster is difficult to occur when the economic development strategy contradicts its comparative advantage. If an industry does not meet the economy’s comparative advantage, completely private investment is difficult to sustain profitability, and thus there would be not sufficient private investment enter the industry. Once again, government needs to use fiscal resources to establish state-owned enterprises or provide adequate subsidies to private capitals to attract them. Nevertheless, since the resources that can be established or subsidized to enterprises are always limited, “catch up” enterprises can not obtain enough support from related and supporting industries.

In sum, comparative advantage is the foundation stone and necessary condition for a country to create and maintain its industrial competitive advantage.

ECONOMIC GROWTH OF DEVELOPING COUNTRY

Competitive advantage theory tells us that countries with relatively high per capita income generally have industries with high level of competitive advantage. [3] But, competitive advantage theory didn’t answer that whether low-income countries (or developing countries) should stride or skip the low-level stage of accumulation and directly create high-level competitive advantage (i.e. kind of economic “catch-up” in order to realize the economic leap development), or should adopt a gradual strategy: begin with their own comparative advantage (for developing country, here is the low-cost competitive advantage) of the industry, then form their own high level of competitive advantage through the gradual accumulation and investment?

For the above problem, the third part of this article has given the answer. The catch-up and leap-type economic development strategy is ultimately difficult to achieve final target. In order to form a high-level competitive advantage and achieve rapid growth in per capita income, the state should first take full advantage of current comparative advantage, maximizing the creation of economic surplus and the accumulation of capital, thereby enabling its endowment structure to be close to the developed countries’, and ultimately gain a competitive advantage and improve people’s income.

In some stages of modern history, Taiwan and South Korea both have a similar resource endowment structure as well as comparative advantage, especially from 1980-2000. In TABLE 1, we were given the R&D intensity and business performance data of Korea’s Samsung Electronics and Taiwan United Microelectronics Corporation (UMC) respectively. Over the years, Samsung has been working through intensive R&D activities to enhance the competitiveness of the products, while UMC is mainly engaged in the chip OEM (work for Original Equipment Manufacturer) which does not require much investment in new product development and focuses on relatively low innovation-based production processes. However, the data present that Samsung, with a lot of investment in R&D activities, performed less well than UMC in terms of operating performance which has a relatively small R&D investment proportion. On the other hand, on the country level, FIGURE 1 shows the comparison of R&D intensity and per capita income between Korea and Taiwan. Similarly with the enterprises, although South Korea’s R&D intensity is much higher than Taiwan, the overall economic development performance is not better than Taiwan.

These cases are accordance with my conclusion. It is important to produce their own economic surplus and maximize capital accumulation through exploiting their comparative advantage, rather than early conduct a vast scale R&D in an attempt to achieve product differentiation.

FIGURE 1

Density of R&D and Per Capita Income: Korea & Taiwan

Description: Left: R&D/GDP, (%); Right: GDP per capita, (dollars)

CONCLUSION

Partial understanding of competitive advantage made some scholars mistakenly believe that comparative advantage theory is outdated and advocate government to upgrade competitive advantage so as to carry out economic “catch-up”. This kind of “catch up” creates a group of enterprises that does not have self survival ability. The state has to suppress the role of market, giving these companies direct and indirect subsidies for the protection, resulting in rent-seeking, and working in low efficiency all of which just achieve the opposite result of competitive advantage.

However, this article is not intended to deny the value of competitive advantage theory. Comparative advantage as a theory of economic development though has pointed out a firm or country should follow its comparative advantage when choosing industries, products, technologies and other productive activities, the firm still can not enter all those industries in which this country has a comparative advantage. In another word, the comparative advantage doesn’t answer what kind of industry that a firm should participate among those industries all possessed the comparative advantage of this country. Instead, competitive advantage theory of the domestic market size, the principles of industrial cluster may be the criterion or references for the enterprise and country to choose a proper industry.